What Is Transfer Pricing?
Transfer pricing governs how related companies price transactions between each other. Learn the rules, risks, and compliance requirements.
Key Takeaways
- Transfer pricing is the price charged for goods, services, or intellectual property transferred between related entities within a multinational group.
- It must follow the arm's length principle, meaning prices should be comparable to what unrelated parties would charge.
- Incorrect transfer pricing can trigger tax adjustments, penalties, and double taxation across jurisdictions.
What transfer pricing covers
When a parent company in the UK sells components to its subsidiary in Nigeria, the price it charges is the transfer price. Transfer pricing rules apply to all intercompany transactions: goods, services, loans, royalties, and management fees. Tax authorities scrutinise these prices because companies could shift profits to low-tax jurisdictions by manipulating intercompany charges.
The arm's length principle
The arm's length principle requires that intercompany prices match what independent parties would agree to under comparable circumstances. If your subsidiary pays your parent company USD 100 per unit for a component that unrelated buyers purchase for USD 60, the tax authority in the subsidiary's country may adjust the price to USD 60 for tax purposes, increasing taxable income locally.
Transfer pricing methods
The OECD recognises five main methods: Comparable Uncontrolled Price, Resale Price, Cost Plus, Transactional Net Margin, and Profit Split. The choice depends on the type of transaction and the availability of comparable data. African tax authorities, including those in Nigeria, Kenya, and South Africa, increasingly require formal transfer pricing documentation using these methods.
Compliance and penalties
Most jurisdictions require companies above certain thresholds to maintain transfer pricing documentation, including a master file, local file, and sometimes country-by-country reports. Failure to comply can result in penalties ranging from fixed fines to a percentage of the underpaid tax. Proactive compliance is significantly cheaper than retroactive adjustments and dispute resolution.